Chasing Shadows: The Dilemma of Crypto Capital Allocation

Shadow Investment = Supporting competitors after missing out on industry leaders, typically to maintain exposure rather than based on differentiated beliefs. By: Zaheer Translated by: Block unicorn Preface This is another article about capital allocation - but this time it's different. Uncertainty always slows everything down, forcing people to reflect on their situation, past, and future. Recent interest rate hikes and global trade and geopolitical uncertainties have caught the cryptocurrency investment world off guard. However, beyond external factors, there are other factors that pose a critical threat to cryptocurrencies. This silent disaster continues to consume people's time, funds, and beliefs: shadow investment. (Shadow Investment = Supporting competitors after missing out on industry leaders, typically to maintain exposure rather than based on differentiated beliefs.) The Genius Problem Finding outstanding talent is the pursuit of every company globally, but talent resources are not unlimited. Geniuses are extremely difficult to find, even harder to demand, and to some extent entirely accidental. Companies with sudden flashes of inspiration cannot predict unexpected outcomes but instead focus their energy and time on creating as many opportunities as possible for talented individuals to emerge. Similarly, venture capital firms face the same problem, as venture capital is not a linear game. Investing more money does not mean producing more geniuses. This was well-known during the early 80s/early 90s and the rise of modern venture capital in the early 21st century, but as investor expectations and appetite have grown, venture capital budgets and the pursuit of talent have grown accordingly. However, this fundamentally conflicts with the venture capital concept - "How do you find more opportunities if they don't exist?" Shadow Investment Enters the Stage Every few years, we encounter a truly game-changing cryptocurrency protocol, project, or business that creates meaningful value. This is the joy of every investor and the work goal of every team. However, the speed and scale of these investments make them (inherently) scarce, and a lack of original thinking leads investors to focus on existing trends, choosing the current hottest option for their next investment. Simply put, investors see new trends in the industry and choose to support the weaker "competitors" of projects they missed. Why This Happens It's well-known that I have many criticisms of the cryptocurrency venture capital field. You can find my complaints in old podcasts, tweets, or articles, but all these comments touch on the same starting point - the cryptocurrency venture capital supernova theory (i.e., too much money in cryptocurrencies, and consequently, too much venture capital). This abnormal state produces many negative external effects in the industry, but continuously funding cheap copies of excellent companies is one of the worst. The current capital allocation process in cryptocurrencies (or any market) is simple: 1. Limited Partners (LPs) invest capital in venture capital firms 2. Venture capital firms invest these funds in startups at different stages 3. Startups use these funds to grow and build their companies This model is simple, but it fails when LPs have too much capital, overfunding cryptocurrency venture capital firms by providing large amounts of money to numerous investors. Today, in the cryptocurrency field, over 20 companies have nine-digit capital, covering from seed to late-stage rounds. If each investment firm (even considering only 20 venture capital firms) makes just one transaction per quarter, there would still be 80 investments in a year. But in reality, the number of transactions is much higher, with hundreds of transactions annually. There aren't hundreds of valuable cryptocurrency companies worth investing in each year. Moreover, there aren't dozens of investable meta-stories or narratives in the cryptocurrency field each year. Instead, we face two truths: 1. Too much money in cryptocurrency venture capital 2. Too few high-quality investable companies But these funds still need to enter the market somehow, as they are designated for companies. Therefore, these funds flow to companies that align with recent investment hot spots: shadow investment. In markets like Layer 1, Layer 2, wallets, perpetual decentralized exchanges, lending protocols, and cross-chain bridges, many projects are poor imitations of each other because the value of original projects drove unfundable demand. Take Uniswap, for example, the pioneer and leader in decentralized exchanges. Hundreds of millions or even billions of dollars have driven cheap imitations of Uniswap but failed to deliver meaningful value or vision iteration. Instead, we're left with an industry landscape destroyed by token inflation. Of course, some companies have built high-quality iterative products, and not every derivative company is a cheap imitation, but these are often exceptions rather than the norm. "Imitators can only follow in the leader's footsteps. They cannot surpass." - Peter Thiel (From Zero to One) A major problem with the cheap imitation strategy in cryptocurrency venture capital is product upgrades and maintenance. Many of the best cryptocurrency projects start with great promise but always promise larger growth visions and extensive maintenance work. This brings numerous issues from protocol security to building a clear product vision. How many project forks have led to millions of dollars being hacked or exploited? The endpoint of the problem points to the venture capital firms funding these transactions. Inevitably, when the entire industry and its best investors cannot distinguish between quality investments and poor imitations, shadow investment will tarnish the industry's reputation. How many funds can we see, how many teams ultimately receive funding for truly launching products? Imitation is flattery, but when the imitation market pays too high a price for something about to die, it is not. If cryptocurrency is to become a serious industry, committed to even superficial capital preservation, then this field and its investors must grow from their financing behaviors and strictly invest in teams truly dedicated to innovation... at least that's what I hope.